Wednesday, March 24, 2010

With the recent publication of the federal government’s third intergenerational report since 2002 we’ve had another surge of concern about the ageing of the population. I want to try to clarify for you what this is likely to involve. It’s been generally portrayed as a bad thing - a threat - but, though it will certainly bring changes, many of those changes will be for the better. Let’s start by being clear on what ageing involves.

What is population ageing?

All of us get older every year, so what does it mean to say the population is ageing? It means the average age of all the people in Australia is rising - though by a lot less than 12 months each year. The average age would be falling if a lot more babies were being born to counter the fact that we’re getting older as individuals but, in fact, women are having fewer children than they used to in earlier decades (even though the fertility rate recovered a little in the noughties). The other factor is that the death rate is falling as we live longer lives. So a lower birth rate and rising longevity are the main causes of population ageing, but it’s being made more acute by the fact that the great bulge in the population that is the baby boomers (people born between 1945 and 1960), which is working its way through like a pig in a python, has reached the point where they’re turning 65 and starting to retire.

The latest report tells us that the number of people aged 65 to 84 is projected to more than double over the next 40 years, while the number over 85 more than quadruples. At present there are five people of working age to support every person of 65 or over, but this is projected to fall by almost half (to 2.7).

The ‘problem’ of ageing is exaggerated

Since a big part of the cause of ageing is that we’re living longer, you’d think this would be seen as a good thing, something to be celebrated. But ageing is almost always portrayed as a bad thing - a cause of many problems - and the latest intergenerational report is no exception. It tells us ageing will cause the economy to grow more slowly - our material standard of living won’t rise as quickly as it has been. As well, we’re told, increased spending on the aged will put great pressure on the federal budget, creating a ‘fiscal gap’ between government spending and revenue equal to 2.75 per cent of GDP by 2050, which is equivalent to about $35 billion a year in today’s dollars.

It’s true that the economy’s likely to grow a little more slowly in coming decades, mainly because of slower growth in the number of people joining the workforce. However, when you examine the report and its projections you find that most of the expected growth in government spending comes not from costs associated with the higher number of old people, but from the rising cost of new health technology and the likelihood that all of us will be demanding more and better healthcare. So the budget will have a problem with inexorably rising spending on healthcare. But though the politicians don’t like to admit it, the obvious solution to that problem is that we’ll all have to pay more tax from our rising incomes over the next 40 years.

It’s true that most other developed countries - the US, Britain, Europe, even New Zealand - will face serious budgetary problems coping with the growing cost of aged pensions and aged care. But that’s because their unfunded pension schemes are much more generous than ours, being unmeans-tested and, in many cases, related to the individual’s pre-retirement income. We don’t have problems to anything like the same degree because our age pension is so frugal, being means-tested and flat-rate. The compulsory super scheme we’ve put in to supplement the age pension - so that most people will retire with a combination of age pension and private pension - is an accumulation scheme that makes no promises about how much you’ll end up with.

Many ageing problems will solve themselves

The next point I want to make is that many of the ageing problems people point to will, to some extent, sort themselves out. Where they don’t, the government will sort them. The point is that our economy is ‘dynamic’ - it changes over time in response to situations that arise. People don’t just sit there accepting their fate, they try to do something about it. And though it’s wrong to imagine that ‘market forces’ have magical powers to eliminate all problems, it’s equally wrong to imagine they have no power to improve matters and that the only solutions come from government action.

Take for instance the often-heard complaint that the babyboomers can’t afford to retire because they haven’t saved enough. There’s truth in this complaint - even though I have to say that this problem arises because the babyboomers are sure they couldn’t get by on the age pension - even though all previous generations have - and even though they haven’t bother to save much. But here’s the real point I’m making: if it’s true the babyboomers can’t afford to retire then they won’t retire. They’ll keep working, even if only part-time. And every year they postpone their retirement is one extra year of saving plus one less year of having to support themselves in retirement.

And, indeed, this trend has already begun. In the 1980s and early 90s we saw a trend towards earlier and earlier retirement. Some of this was voluntary - such as federal public servants whose pension scheme had a quirk that encouraged them to retire just before they turned 55 - but a lot was involuntary, particularly for less-skilled blue-collar workers being made redundant from manufacturing. As you know, people are able to get access to their superannuation savings from the age of 55 - and earlier if they’re made redundant.

But that was a long time ago, and though some public servants may still be retiring early because of quirks in their super schemes, for about the past decade the tide has been turning and the proportion of 55 to 64 year-olds participating in the labour force has been rising, not falling. That is, people are tending to retire later. Since 2001 the participation rate for men aged 55 to 59 has risen from less than 72 per cent to more than 78 per cent. Since 1993 the participation rate for men aged 60 to 64 has risen from 54 per cent to almost 60 per cent. I expect this trend has a lot further to run.

You can see the federal government seeking to reinforce this trend, first by phasing up the female age pension age from 60 to 65; second, by introducing tax-free treatment of retirement income provided the individual has turned 60; and now in last year’s budget by beginning to phase the age pension age up to 67. The limited outcry over these moves is a sign they fit with people’s changing social attitudes. We’re living a lot longer than we used to, and are healthier than we used to be, so it follows that we can work for more years before we retire. It doesn’t make much sense for all of our extra years of life to be spent in retirement. What about manual workers whose bodies may not hold up for another two years to 67? We already make provision for them - disability support pension.

The pension age is being raised in most developed countries and I don’t think we’ve seen the last of our government’s efforts to raise the de facto retirement age. The next step - which may be recommended in the Henry tax reform report - would be to raise the age at which tax-free retirement benefits are available to align it with the age pension age. Nor do I think that 67 is the highest the pension age will go.

It’s often said that, whether or not older people want to keep working, they can’t because of employer prejudice against older workers. Older workers are the first to be laid off and the last to be rehired, we’re told. I’m sure there was a lot of truth to this complaint and there may be some lingering vestige of such a prejudice, but I’m equally sure it’s disappearing and probably largely gone.
Why? Because, at a time of population ageing, where skilled labour is perpetually in short supply, it’s a luxury employers can no longer afford. And most of them have already figured that out.

So I believe employers’ attitude towards older workers is in the process of reversing itself. One consequence of ageing is that fewer and fewer young people will be leaving education each year and joining the workforce (though this will be countered to some extent if we achieve high levels of skilled immigration). This being the case, employers will be anxious to retain the services of their existing, older - but skilled and experienced - workers. They’ll generally be sorry to see them retire and willing to offer the flexible arrangements necessary to have them stay on, even if only part-time.

Older workers possess something economists call ‘firm-specific knowledge’. They know how things are done; they know why they’re done that way and not some other way. When in the recessions of the early 1980s and the early 1990s big companies followed the corporate fashion of the time and sought to impress the sharemarket by announcing mass redundancies, they learnt the hard way that getting rid of your older workers involved also excising the firm’s ‘corporate memory’, so that it lost the ability to do certain things. Some of these key people had to be brought back, sometimes at great expense and as an admission of error. It’s no longer fashionable for big companies to try to impress with huge layoffs, and I suspect that part of the reason for this is the belated recognition that getting rid of your corporate memory isn’t a smart thing to do.

As older workers become more inclined to stay on, and employers become more desirous of having them stay on, governments are increasingly likely to change the tax laws to accommodate and encourage this trend. That’s because reversing the trend to early retirement represents the easiest and most obvious way to reduce the economic and budgetary costs of ageing. The next best way is to do more to help mothers return to the workforce and help more to work full-time rather than part-time. It’s probably no coincidence that we’re now finally seeing some action on paid parental leave.

The changing balance of supply and demand for labour

The key to understanding how ageing will affect workers is to understand the basic economic forces we’re dealing with - the changing balance of the supply and demand for labour. You also need to understand where we’re coming from. The economy is now emerging from a period of about 30 years - starting in the mid-1970s - when the number of people wanting to work greatly exceeded employers’ demand for workers and the rate of unemployment was always high. According to the economic textbook, such a position can’t be sustained because the price of labour (wages) will always adjust to bring supply and demand into balance. But the labour market doesn’t work the way textbooks say it does and, as I say, we went through a protracted period in which the supply of labour exceeded demand.

The supply of people wanting work was plentiful for three main reasons. First, because of the high fertility rate in the 50s, 60s and 70s, a lot of young people were entering the labour force each year. Second, because the bulge of babyboomers were at their prime working age. And third, because changing social attitudes and rising levels of educational attainment were prompting a lot of married women to return to the workforce.

As a consequence of this period of excess supply of labour, the balance of power in industrial relations shifted decisively in favour of employers. We saw a marked decline in strikes and other industrial disputes and, indeed, the steady decline of the union movement. More to the point for our present purposes, employers realised there was rarely any shortage of people wanting to work for them and so they became a lot more picky. They could demand higher levels of education than were needed to perform the tasks involved; they could favour married women over young people (more reliable); they could decline to interview any job applicant who’d been unemployed for more than a month or so and, above all, at a time of rapidly changing technology they could favour hiring young people over older people, whether those oldies were job applicants or existing employees. I can remember a time in the days of the Fraser government when there were concerns about high youth unemployment, it was considered virtuous to bundle older workers into retirement to make way for the younger generation.

Why did employers behave like this? Because the excess supply of labour allowed them to. The trouble is, because this excess lasted for 30 years, many people have come to regard it as part of the natural order - the way the world has always worked and always will.

In truth, that era has ended and we’ve entered a new era where employers’ demand for labour now exceeds the supply of people wanting to work. And this means the balance of industrial power is shifting from the employers back to the workers, just where it was in the post-war period that ended in the mid-70s. Why has the balance of supply and demand shifted? In a word, because of ageing. With an older population, you get more people who consume but don’t produce. So the demand for labour remains strong, but the supply of labour declines. To be more specific, we have fewer young people joining the workforce each year as the low rates of fertility in the 80s and 90s have their effect and as the babyboomers start surging into retirement.

The point is, it’s this change in the balance of demand and supply that gives workers the upper hand and forces employers to change their behaviour in line with the changed economic reality.

Employers will stop favouring young people over older people because they have to. There just won’t be enough young people entering the labour market to allow them to discriminate against older workers.

More generally, shortages of skilled labour will become commonplace, and rather than giving their workers a hard time, employers will have to try harder to retain the services not just of older workers but of all workers and discourage them from being poached by rival firms. Salaries will be higher, perks will be greater and employers will be a lot more solicitous of their workers’ welfare. Firms will vie to be seen as the ‘employer of choice’ in their industry. Why will they? Economic necessity.

This is the amazing thing about the portrayal of ageing as a great problem for the economy. It will be a problem for employers, but just the opposite for workers.

Before I move on, let me warn you about something. At about the time of the first intergenerational report in 2002, people focused their minds on ageing, looked at their existing workforces and noticed the high proportion of babyboomers, all of whom were about to retire. They did a bit of manpower planning and projected that, within 10 or 20 years there’d be huge shortages of doctors, nurses, teachers and many other professions. You could add all these shortages together and conclude that, with all these unfilled vacancies, the economy will surely grind to a halt. But I warn you against such a conclusion. Why? Because, as I said at the beginning, the economy is dynamic. Or to put it another way, because nature abhors a vacuum. Those massive projected shortages won’t transpire because, to a greater or lesser extent, people will find a way to overcome them. They’ll try to attract skilled immigrants, they’ll look for labour-saving solutions, they’ll allow nurses to do the work of doctors, or whatever.

I haven’t left myself much time to talk about the effect of the resources boom. In the last part of the noughties, immediately before the global financial crisis, we were in the grip of a resources boom, getting sky high prices for coal and iron ore as China and India undertake the massive and protracted installation of all manner of infrastructure needed to turn them into developed economies. The result for us was a booming economy, the lowest unemployment rate in 30 years and widespread shortages of skilled workers. We’ve been through resources booms before and the GFC seem to bring that one to an end as all the others had ended. But China and India turned out not to be greatly affected by the global recession. They have resumed their rapid march towards economic development, their demand for our resources has continued unabated and, after falling somewhat, resource prices are on the way up. We’re in for another period of huge investment in increased mining capacity, including a huge investment in LNG facilities. So the resources boom is back on, it seems like it won’t be long before the economy is back to full employment and skill shortages, and Asia’s heightened demand for our minerals and energy could run on for a decade or two.

If so, this will have profound effects on our economy. It will keep our exchange rate and interest rates high, and lead to a much bigger mining sector, but smaller manufacturing, agriculture and tourism sectors. It will change the mix of occupations accordingly, and it will change the nation’s geographic balance, favouring rapid growth in Western Australia and Queensland and much slower growth in the other states. Population will shift to the mining states as it has been for some time. That will be great for Queensland, though it will continue suffering the same problems it’s been suffering from for a while: growing pains.

Thursday, March 18, 2010

Talk to Graduate School of Government, University of Sydney
March 18, 2010

Before I get on to talking about the policy response to the GFC I want to go back to first principles and remind you that while, as public servants, you take government policy activity for granted - it’s what you’re employed to do - the appropriate role of government (whether, and under what circumstances, governments should intervene in markets) is perhaps the most contentious topic in politics and economics. The political philosophy of libertarianism - which gives primacy to individual liberty and carries a presumption against the need for government intervention - is overrepresented in the political debate in Australia and particularly the US. While by no means all economists are libertarians, most have a big streak of it in them because the dominant model of conventional, ‘neo-classical’ economics is built on the assumptions that people always act rationally and that markets are self-righting.

The ground rules for intervention

While the public is always urging governments to intervene to correct problems, real or perceived, and politicians are almost always keen to leap in, economists have a two-stage test before they accept such a need: 1) a significant instance of ‘market failure’ has to be demonstrated and 2) the ability of government intervention to correct the market failure - or at least do more good than harm - has to be demonstrated.

Market failure arises where:

a) there is insufficient competition within the market to produce the outcomes the model promises, or

b) there are ‘externalities’ (that is, where the actions of the participants in a market transaction have consequences for third parties [eg the wider community] whether those consequences are negative [eg generation of pollution] or positive [eg my education -or my invention of some improved technology - benefits other people]), or

c) where the goods or services being exchanged display the qualities of ‘public goods’. The two key qualities are that they a non-rivalrous (my consumption of the good doesn’t reduce the quantity of it available to others eg knowledge, use of the internet) and non-excludable (no one can be effectively excluded from using the good eg free-to-air television). The standard egs of public goods are lighthouses and defence spending, but there are other, less perfect examples. The free market will produce less of a public good than is in the best interests of the community because it’s so hard for private firms to make sufficient profit from producing it. This is why governments often end up producing those goods and services which have partial or complete public goods characteristics.

Other classes of market failure arise because of transaction costs, agency problems, or information asymmetry.
But there is also such a thing as government failure - where government intervention in the market makes things worse rather than better, or when the modest benefits don’t justify the considerable costs (eg the home insulation scheme?). There is a political/economic theory known as ‘public choice’ which holds, among other things, that politicians and bureaucrats always act in their own interest rather than the public’s interest, and that, whatever their original motivations, all government regulation of industry ends up being captured by the industry and turned to the industry’s advantage in, say, reducing competition within the industry (to the incumbents’ advantage), increasing protection or in persuading the government to subsidise industry costs.

Where I do stand in this debate? I believe market failure is common and that governments should usually act to correct it. But I also believe in govt failure and some degree of truth in the public choice critique. Governments and their bureaucrats do sometimes act in their own interests rather than the public’s and some regulation is captured and perverted by those being regulated. So I believe in intervention, but I also believe that getting intervention right, minimising unintended consequences and doing more good than harm is a tricky business, requiring a lot of careful thought, trial and error, experimentation, learning from experience and project evaluation. This is why I’m pleased to see you studying Policy in Practice and interested in discussing the choice of appropriate policy instruments.

Now let’s turn to the GFC. But before we do, let me just say this: one reason I was moved to remind you of the libertarian, free market, laissez faire view of the world is that it’s been very much in evidence in the debate about the causes and cures of the GFC, particularly in the US. It seems blatantly obvious to most people (including, I think, most economists) that the GFC is a case of massive market failure, but there have been plenty of libertarian-leaning economists in the US (and some here) willing to argue the crisis was really the product of government failure - government intervention gone wrong - and argue that the proposed regulatory response to correct the problem was unnecessary or even counterproductive. This, of course, is a line of argument that powerful interests in the financial markets are happy to hear and willing to sponsor.

I could talk about the GFC from a global perspective, but I’m going to concentrate on the Australian perspective - which, of course, is very different from that of the North Atlantic economies in the eye of the storm. (You can draw me out on the more global view in question time.)

The policy response to the crisis can be divided into two strands: 1) the macroeconomic response - the policy actions necessary to restore stability to the real economy, to lessen the recession and hasten the recovery and 2) the regulatory response - the policy actions necessary to correct the regulatory failures that permitted the crisis to occur and reduce the likelihood of a similar crisis recurring. I’m going to devote most time to discussing the choice of instruments in the macroeconomic response, but I will briefly discuss the prudential regulation response. (Again, you can draw me out in questions.)

The two main instruments available for macro management - the short-term stabilisation of demand as the economy moves through the business cycle - are fiscal policy (the manipulation of govt spending and taxation to influence the strength of demand) and monetary policy (the manipulation of interest rates to influence demand). Under the Keynesian influence, fiscal policy was the dominant instrument used in the post-war period, but from the mid-1970s the dominance switched to monetary policy. I want to start by explaining why fiscal policy fell out of favour with policy-makers - why they changed their view on which policy instrument was more appropriate for use in the day-to-day management of aggregate demand - and then explain why, contrary to that established view that fiscal policy was passé, it has been given a major role in the macro response to the GFC, both here and around the world.

Why fiscal policy fell out of favour with policy-makers

There has never been any denial that the budget’s automatic stabilisers should and do play an important counter-cyclical role. Rather, the query has been over discretionary policy. At least since the time of the Fraser government, monetary policy has been the primary instrument used for the short-term management of demand, with fiscal policy playing a back-up role at best. There was a great concern that policy adjustments needed to be more timely, to ensure their effects on economic activity were counter-cyclical rather than pro-cyclical. Policy-makers identified three causes of delay, and concluded that monetary policy was better than fiscal policy on two out of the three.

First, the recognition lag - the time it takes policy makers to realise that a policy adjustment is needed. This is caused mainly by delays in the publication of economic indicators and, on the face of it, you would expect it to apply equally to both policy arms. However, monetary policy has sought to reduce the lag by adopting a forward-looking or pre-emptive approach where policy adjustments are based on forecasts of inflation, with actual indicators used mainly to update the forecasts. Particularly because of the next point, this is easier to do with monetary policy than fiscal policy.

Second, the implementation lag - the time it takes to actually change the policy setting after it has been decided that it should be changed. Here, monetary policy wins hands down; it’s significantly more flexible. The stance of monetary policy is reviewed at every monthly meeting of the Reserve Bank board and could be changed even more frequently if necessary. Changes are easily implemented the following morning after the decision has been made. Policy can be changed in small or large, frequent or infrequent steps, without any implication that earlier decisions were wrong. By contrast, fiscal policy is usually adjusted only in May each year and though mini-budgets are possible, for them to come too soon after a budget, or for there to be too many of them, could attract criticism over short-sightedness. More significantly, there are delays while cabinet decides the particular tax or spending changes to make, while the legislative authority is passed through parliament, and while the administrative arrangements needed to put decisions into effect are put in place.

Third, the transmission lag - the time it takes for the implemented measure to affect economic activity. Here, fiscal policy wins. Government spending affects economic activity as soon as the money leaves the government’s coffers, while tax cuts or cash bonuses (transfer payments) affect activity as soon as the recipient chooses to spend the money. By contrast, Reserve Bank research shows that a sustained change in interest rates of 1 percentage point causes a change of 0.33 percentage points in real GDP in the first year, with a further 0.33 points in the second year and a further 0.17 points in the third, giving a total effect after three years of 0.83 percentage points.

But despite this advantage on the transmission lag, fiscal policy lost out because of its poor performance on the recognition and implementation lags.

Why fiscal policy is back in favour

It was always easy to predict that fiscal policy would come back into fashion just as soon as the economy dipped into recession. The politician who could resist the temptation to use the budget to stimulate the economy during recession has yet to be born.

But there were two other, more economic arguments favouring greater reliance on fiscal policy which arose from the particular nature of the global financial crisis. First, the synchronized nature of the global recession - because all developed economies were hit at the same time by the same developments in global capital markets - gave fiscal policy a comparative advantage. When a single country goes into recession, easing monetary policy can help stimulate the economy also by lowering its exchange rate, thus making its export and import-competing industries more price competitive. But that can’t happen when all the country’s trading partners go into recession and ease monetary policy at the same time, because there’s no one to depreciate against.

When a single country goes into recession, easing fiscal policy has the disadvantage that some proportion of the stimulus leaks overseas in the form of higher imports. But in a synchronized recession, when all countries ease fiscal policy at the same time their leakages cancel each other out. Each country suffers a leakage from imports, but also enjoys an injection from exports.

Second, the fact that this global recession had its origin in a crisis on the financial side of the economy was another factor counting in favour of fiscal policy. When you’ve got an impaired banking system, lower interest rates may not be passed through to households and businesses and, even if they are, the banks may be unwilling to lend. Further, if you’ve got an impaired banking system, the official interest rate will probably soon be close to zero, leaving no further room for conventional monetary easing, although ‘quantitative easing’ remains open. Countries in this situation are caught in the legendary Keynesian ‘liquidity trap’ - a classic justification for favouring fiscal policy over monetary policy.

That last argument doesn’t apply to Australia, of course, but all of these arguments explain why the circumstances of this global recession prompted even the ultra-orthodox International Monetary Fund to urge its members to respond to the downturn with fiscal policy.

A further, local factor is that, this time, worries about the recognition and implementation lags were countered by the peculiar nature of this crisis. We were able to see the shock coming, and start acting to counter it, well before it actually reached us across the Pacific (apart from the instantaneous effect on business and consumer confidence as Australians watched the crisis unfolding on TV every night).

Before we move on, I should warn you that fiscal policy has not replaced monetary policy as the dominant instrument of macro management. And Dr David Gruen of our Treasury has noted that the special circumstances that made fiscal policy such a necessary and major element in the response to the GFC aren’t likely to be present in future recessions.

The regulatory response to the GFC

As you know, in the heat of the crisis, in October 2008, the Rudd government responded by producing two new policy instruments: the government guarantee of all small deposits in banks and other deposit-taking institutions. This was in response to a lot of people moving their money to banks they perceived to be bigger and safer, thus causing significant problems for some of our smaller banks. An unwanted side effect of the guarantee was to prompt other people to move their savings out of unguaranteed non-bank trusts (such as mortgage trusts) requiring those trusts to freeze withdrawals for a time. Second, the government guaranteed the bank’s large deposits and wholesale funding, in return for a variable fee. This was necessary to ensure they could continue to obtain the considerable overseas funds they needed to continue operating, in the face of a world where most other developed countries’ government had guaranteed their banks. Because this latter guarantee was quite expensive for the banks, they stopped using it as soon as they could, and now it will be removed at the end of this month. It tended to advantage the bigger banks over the smaller ones. As yet, nothing has been done to regularise the guarantee of small deposits, which the government should really be charging for, thereby reducing the competitive advantage accorded to the guaranteed sector.

Looking at the regulatory response more broadly, I won’t discuss the regulatory failures that permitted the crisis to occur - particularly as there weren’t any great failures in the regulation of our banks - but go straight to discussing the improvements in regulatory instruments being worked up at the international level by two bodies associated with the Bank for International Settlements in Switzerland (the central bankers’ club): the Basel Committee on Banking Supervision and the Financial Stability Board. As part of the G20’s renovation of these bodies, Australia has a seat on both.

They are working on proposals to tighten up the international standards on the adequacy of the capital banks are required to hold - that is the limits on the extent to which banks may increase their gearing - including by closing loopholes in the capital adequacy standard and by introducing a supplementary leverage ratio. They are also working up proposals to require banks to improve their liquidity - their ability to pay their debts as they fall due - by holding greater highly liquid assets (such as government bonds, which can really be sold on the market) sufficient to tide them over for, say 20 days, if their short-term funding was suddenly cut off (as it was during the crisis).

This is all fine and much needed internationally, but the Australian banks - and the Australian authorities, especially APRA and the Reserve Bank - are concerned that the rules may be more onerous here than is justified by the good performance of our banks. These rules will increase the cost of ‘intermediation’ - which is what banks do, act as an intermediary between savers and investors, lenders and borrowers. Raising the cost of intermediation would mean widening the gap between the average interest rate the banks pay to borrow funds and the average interest rate the banks charge their borrowers. This increased cost would be passed on to the banks’ customers, particularly their borrowers. These higher interest rates to borrowers would act to dampen economic growth. That is, there is a price to be paid for making banking safer and less exposed to crises. A particular worry of the Australian banks and our authorities is that, as the liquidity requirement now stands, it would require our banks to hold more government bonds than are actually on issue.

Once the new capital and liquidity standards have been agreed on internationally, it will be up to the national authorities in each country (APRA in our case) to adapt them to local conditions and apply them locally. In theory, this means we don’t have to comply with any requirement that doesn’t suit us. In practice, however, we will be under considerable pressure from other countries to comply with the higher standards. Our banks need to borrow from overseas and want to operate in other countries, and their reputations would suffer if a perception arose that they were being inadequately regulated at home.

At present, our authorities are working on the two committees to ensure the final requirements are sufficiently flexible to accommodate the Australian case. To the extent that they fail, APRA will have to walk a fine line to modify the new standards in a way that doesn’t damage Australia’s reputation.